FUNDAMENTALS OF ACCOUNTING

ADJUSTING THE ACCOUNTS

(End-of-the-Period Adjustment)

Ms. Daizy Marie P. Nicart, CPA

 Learning Objectives

After studying the topic, we should be able to:

❑ Explain the accrual vs. cash basis of accounting.

❑ Know and understand the purpose and types of

adjusting entries.

❑ Accurately record adjusting entries

 The Accounting Cycle

Transactions

9. Reversing entries 1. Journalizing

8. Post-closing trail balance 2. Posting

7. Closing entries 3. Trial balance

Work
6. Financial Statements Sheet 4. Adjustments

5. Adjusted trial balance

 Timing Issues

Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).

.....
Jan. Feb. Mar. Apr. Dec.

◆ Generally a month, a quarter, or a year.

◆ Also known as the “Periodicity Assumption”
Timing Issues
Timing IssuesTiming Issues

Recognizing Revenues and Expenses

Revenue Recognition Principle
Recognize revenue in the
accounting period in which it
is earned.

In a service enterprise,
revenue is considered to be
earned at the time the
service is performed.
 Timing Issues

Recognizing Revenues and Expenses

Expense Recognition Principle
Match expenses with
revenues in the period
when the company makes
efforts to generate those
revenues.

“Let the expenses follow

the revenues.”
 Timing Issues

Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting
◆ Transactions recorded in the periods in which the
events occur.

◆ Revenues are recognized when earned, rather than

when cash is received.

◆ Expenses are recognized when incurred, rather than

when paid.
 Timing Issues

Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
◆ Revenues recognized when cash is received.

◆ Expenses recognized when cash is paid.

◆ Cash-basis accounting is not in accordance with

generally accepted accounting principles (GAAP).
 Accrual vs. Cash – Basis Accounting

Illustration :
A client paid the Sea Wind Resort in Boracay
Island P7,000 on April 8, 2023 for a one-day
deluxe accommodation on May 13, 2023.

When will the revenues be recognized under

Accrual and Cash Basis Accounting?
 Adjusting Entries

Adjusting Entries

Adjusting Entries are journal

entries which are to be recorded
in the General Journal and are
usually prepared at the end of an
accounting period following the
preparation of a Trial Balance.
 Adjusting Entries

Purpose of Adjusting Entries

It is our primary objective to present a
correct financial statements which are
truly “test-meters” of the financial
condition of the business as of a particular
date and the results of operation at the
end of the accounting period.

Generally, adjusting entries are prepared for the following reasons:

a) To bring records or balances of accounts updated

b) To properly match revenues against expenses during the period.

 The Basics of Adjusting Entries

◆ Adjusting entries are necessary because the trial

balance may not contain up-to-date and complete
data.

◆ Ensure that the revenue recognition and expense

recognition principles are followed.

◆ Required every time a company prepares financial

statements.

◆ Will include one income statement account and

one balance sheet account.
 The Basics of Adjusting Entries
Types of Adjusting Entries
Deferrals
1. Prepaid Expenses.
Expenses paid in cash and
recorded as assets before
they are used or consumed.
2. Unearned Revenues.
Cash received and recorded
as liabilities before revenue
is earned.
Accruals
3. Accrued Revenues.
Revenues earned but not yet
received in cash or recorded.
4. Accrued Expenses.
Expenses incurred but not
yet paid in cash or recorded.
 The Basics of Adjusting Entries

Types of Adjusting Entries

Provisions Others
5. Provision for Depreciation 7. Adjustment on Inventories
of Property and Equipment this is typical in
or Fixed Assets. Expenses merchandising and
for the use of assets are manufacturing concern.
recorded.
6. Provision for Estimated 8. Correction of Erroneous
Uncollectible Accounts Journal Entries.
(Bad Debts).
Record expense of
extending credit.
 The Basics of Adjusting Entries

Types of Adjusting Entries

Trial Balance –
Each account is
analyzed to
determine
whether it is
complete and up-
to-date.
 Deferrals

Adjusting Entries for Deferrals

Pre-collected Income and Prepaid Expense Adjustment

Deferrals are either:

◆ Prepaid expenses
(Prepayments)

OR

◆ Unearned revenues/
Pre-collected income
 Deferrals

Prepayments
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

◆ insurance

◆ supplies
◆ Rent

◆ advertising
 Deferrals

Prepayments
◆ Expire either with the passage of time or through use.

◆ 2 methods of recording prepayments :

► Asset Method if an asset account is debited upon

payment

► Expense Method if an expense account is debited

upon payment
 Deferrals

Prepayments
Asset Method :

◆ Adjusting entry:

► Increase (debit) to an expense account and

► Decrease (credit) to an asset account.

 Prepaid Expense : Asset Method

Illustration: Pioneer Advertising Agency

purchased supplies costing P2,500 on
October 5. Pioneer recorded the payment
by increasing (debiting) the asset
Supplies. This account shows a balance
of P2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
P1,000 of supplies are still on hand.

Oct. 31 Supplies expense 1,500

Supplies 1,500
 Prepayments : Asset Method
Illustration: On October 4, Pioneer
Advertising Agency paid P60,000 for a
one-year fire insurance policy. Coverage
began on October 1. Pioneer recorded
the payment by increasing (debiting)
Prepaid Insurance. This account shows a
balance of P60,000 in the October 31
statement of financial position. Insurance
of P5,000 (60,000 / 12) expires each
month.

Oct. 31 Insurance expense 5,000

Prepaid insurance 5,000
 Deferrals

Prepayments
Expense Method :

◆ Adjusting entry:

► Increase (debit) to an asset account and

► Decrease (credit) to an expense account.

Expense Asset
 Prepaid Expense : Expense Method

Illustration: Pioneer Advertising Agency

purchased supplies costing P2,500 on
October 5. Pioneer recorded the payment Supplies purchased:
Record expense
by increasing (debiting) the Supplies
Expense. This account shows a balance
of P2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that Adjust for remaining
supplies
P1,000 of supplies are still on hand.

Oct. 31 Supplies 1,000

Supplies Expense 1,000
Deferrals : Analysis
 Prepayments : Expense Method
Illustration: On October 4, Pioneer
Advertising Agency paid P60,000 for a
one-year fire insurance policy. Coverage
began on October 1. Pioneer recorded Insurance purchased:
Record expense
the payment by increasing (debiting)
Insurance Expense account. This
account shows a balance of P60,000 in
the October 31 statement of financial
performance. Insurance of P5,000
(60,000 / 12) expires each month. Set up asset for the
unexpired portion

Oct. 31 Prepaid Insurance 55,000

Insurance Expense 55,000
 Prepaid Expense : Illustration 3

On September 1, 2022, ABC Commercial paid an insurance

premium covering the period from September 1, 2022 to September
1, 2023 in the amount of P36,000 . The accounting period ends on
December 31, 2022.

Requirement:
Prepare the journal entry on September 1, 2022 and December 31,
2022 assuming:

a. Asset Method is used to record the Sept. 1, 2022 transaction.

b. Expense Method is used to record Sept 1, 2022 transaction.
 Deferrals : Unearned Revenues

Unearned Revenues / Pre-collected Income

Receipt of cash that is recorded as a liability because the
revenue has not been earned.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

◆ Rent
◆ Airline tickets
◆ Magazine subscriptions
◆ Customer deposits
 Deferrals : Unearned Revenues

2 Method of Recording Unearned Revenues

◆ Liability Method: a liability account is credited upon
collection or receipt of cash. This method is called
“real approach”.

◆ Income Method: an income account is credited upon

collection or receipt of cash. This method is called
“nominal approach”.
 Deferrals : Unearned Revenues

Unearned Revenues : Liability Method

◆ Adjusting entry is made to record the revenue that
has been earned and to show the liability that remains.

◆ Results in a decrease (debit) to a liability account

and an increase (credit) to a revenue account.
 Unearned Revenues : Liability Method

Illustration: Pioneer Advertising Agency received P12,000 on

October 2 from R. Knox for advertising services expected to be
completed by December 31. Unearned Service Revenue shows a
balance of P12,000 in the October 31 trial balance. Analysis
reveals that the company earned P4,000 of those fees in October.

Oct. 31 Unearned service revenue 4,000

Service revenue 4,000
 Deferrals : Unearned Revenues

Unearned Revenues : Income Method

◆ Adjusting entry is made to adjust the revenue that to
reflect what has been earned and to set up the liability.

◆ Results in a decrease (debit) to a revenue account

and an increase (credit) to a liability account.

Revenue Account

Revenue Liability
 Unearned Revenues : Income Method

Illustration: Pioneer Advertising Agency received P12,000 on

October 2 from R. Knox for advertising services expected to be
completed by December 31. Service Revenue account shows a
balance of P12,000 in the October 31 trial balance. Analysis
reveals that the company earned P4,000 of those fees in October.

Oct. 31 Service revenue 8,000

Unearned Service revenue 8,000
 Unearned Revenues : Ilustration 2

On July 15, 2022, H. Gregorio collected in advance cash of

P48,000 from a tenant of her building. This represents rental which
cover from August 1, 2022 to August 1, 2024.

Required: Prepare journal entries on July 1, 2022 and December

31, 2022 assuming

a)Income Method
b.) Liability Method
 Deferrals AJE : Exercises
Requirement: Determine the adjusting entry needed at end of period.

Case 1:
On March 1, 2023, Customer D rented one room in the building and
paid P120,000 to the company representing one year rent. The
accountant recorded the amount as Unearned Rent.

Case 2:
Last July 1, 2023, the company decided to embark on an
advertising campaign to promote the business. An advertising
contract was entered with ABS-CBN. Amount of the contract was
P600,000, covering one year, and was paid on the same date. The
asset method was used in recording this amount. As of July 31,
2023, P100,000 of the contract price has already been consumed.
 Deferrals AJE : Exercises
Requirement: Determine the adjusting entry needed at end of period.

Case 3:
Supplies expense account has a balance of P3,000 representing
the amount of supplies bought during the period. Supplies on hand
at the end of December amounted to P1,000.

Case 4:
On June 1, 2023, the business entered into a one year advertising
contract with XYZ Advertising Co. A payment of P12,000 was
made on that date and was charged to advertising expense.
 Accruals

Adjusting Entries for Accruals

Accruals are made to record

◆ Revenues earned

OR

◆ Expenses incurred

in the current accounting period that have not been

recognized through daily entries.
 Accruals

Accrued Revenues
Revenues earned but not yet received in cash or recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

◆ Rent ◆ Services performed
◆ Interest
 Accruals

Accrued Revenues
◆ Adjusting entry shows the receivable that exists and
records the revenues earned.

◆ Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
 Accruals

Illustration: In October Pioneer Advertising

Agency earned P200 for advertising services
that had not been recorded.

Oct. 31

Accounts receivable 200

Service revenue 200

On November 10, Pioneer receives cash of

P200 for the services performed.

Nov. 10 Cash 200

Accounts receivable 200
Accruals : Analysis
 Accruals : Illustration 2

Angel Company decided to invest P1,200,000 excess cash in a

money market instrument on April 1, 2023. The instrument
carried an 8% annual rate of interest and a 1-year term to
maturity. Interest is withdrawn at maturity.

Required:
1. What amount of income will be recognized for the year
ending December 31, 2023?
2. Prepare adjusting journal entry on December 31, 2023.
 Accrued Expenses

Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

◆ Rent ◆ Taxes
◆ Interest ◆ Salaries
 Accrued Expenses

Accrued Expenses
◆ Adjusting entry records the obligation and recognizes the
expense.

◆ Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
 Accrued Expenses

Illustration: Pioneer Advertising Agency signed a three-month

note payable in the amount of $5,000 on October 1. The note
requires Pioneer to pay interest at an annual rate of 12%.

Oct. 31 Interest expense 50

Interest payable 50
 Accrued Expenses

Illustration 2: Pioneer Advertising Agency last paid salaries on

October 26; the next payment of salaries will not occur until
November 9. The employees receive total salaries of P20,000 for a
five-day work week, or P4,000 per day. Thus, accrued salaries at
October 31 are P12,000 (P4,000 x 3 days).
Accrued Expenses
Accrued Expenses
 Depreciation

Depreciation

◆ Buildings, equipment, and vehicles (assets with long

lives) are recorded as assets, rather than an expense,
in the year acquired.

◆ Companies report a portion of the cost of the asset as

an expense (depreciation expense) during each period
of the asset’s useful life.

◆ Depreciation does not attempt to report the actual

change in the value of the asset.
 Property Plant and Equipment and the
Related Depreciation
Depreciation Expense – the portion of the property and
equipment that should be allocated over the number of
years and chargeable against expenses during the period.

2 Kinds of Depreciation

1. Physical depreciation – due to wear and tear because

of frequent use, passage of time and action of the
elements
2. Functional or economic depreciation – obsolescence or
inadequacy of the asset to perform efficiently.
 Straight Line Method of Computing
Depreciation

Three factors useful in computing depreciation:

1. Acquisition cost – the amount paid or liability

incurred when the asset is acquired.
2. Scrap Value – the estimated value of the asset
at the end of its economic or useful life. Also
called salvage value or residual value.
3. Estimated Economic or Useful Life – the
estimated length of time usually stated in years
that the asset can be of use.
 Straight Line Method of Computing
Depreciation

ANNUAL Cost of the Asset - Salvage Value

=
DEPRECIATION Estimated Life of the Asset
 Compute for the annual depreciation

On October 1, 2022, Metro Davao Commercial

acquired air conditioning unit for office use costing
P80,000. Freight paid was P5,000 and cost of
installation was P15,000. The estimated useful life
is 5 years and a residual value of P10,000.

Compute for the annual depreciation and give the

adjusting entry at the end of Dec. 31, 2022.
 Depreciation

Illustration: For Pioneer Advertising,

assume that depreciation on the
equipment is $480 a year, or $40 per
month.

Oct. 31

Depreciation expense 40
Accumulated depreciation 40

Accumulated Depreciation is called a contra asset account.

Depreciation
Depreciation & Accumulated Depreciation

Statement Presentation

◆ Accumulated Depreciation is a contra asset account.

◆ Appears just after the account it offsets (Equipment)

on the balance sheet.

◆ Normal balance of a contra asset account is a credit.

 Accrual : Illustration

A building owned by Cebu Holdings Inc. was partly

rented by Bank of the Philippine Island for
P100,000 per month payable every 2nd day of the
following month. The rental for the month of
December 2014 will be paid on January 2, 2015.

Analyse how this will be recorded on the books of

Cebu Holdings Inc. and Bank of the Philippine
Island.
 Effects of Error / Omission on FS

Book of Cebu Holdings, Inc. Book of Bank of Phil. Island

➢ Failure to record Accrued Rent ➢ Failure to record Rent Expense
Income Receivable will will understate total expenses
understate assets in the in the Income Statement.
Balance Sheet.

➢ Failure to record Rent Income ➢ Failure to record Accrued Rent

will understate total income in Expense or Payable will
the Income Statement and as a understate the liability in the
consequence, profit will be Balance Sheet and as a
understated. consequence, profit will be
overstated.
➢ Understated profit will
understate Owner’s Equity ➢ Overstated profit will overstate
Owner’s Equity
 Illustration : Deferral of Pre-collected
Income
On October 1, 2014, Land Holdings Realty Co. collected
P12,000 from a tenant representing an advance collection
from building rental for one year. The accounting period
ends on December 31, 2014.

Upon receipt of cash:

COMPARATIVE JOURNAL ENTRIES
Income Method Liability Method
Cash 12,000.00 Cash 12,000.00
Rent Income 12,000.00 Unearned Rent Income 12,000.00
To record collection of advance rental To record collection of advance rental
for the period from Oct. 1, 2014 to for the period from Oct. 1, 2014 to
Oct. 1, 2015 Oct. 1, 2015
 Adjusting Entries at end of the year

COMPARATIVE JOURNAL ENTRIES

Upon Income Method Liability Method
receipt Cash 12,000.00 Cash 12,000.00
of cash Rent Income 12,000.00 Unearned Rent Income 12,000.00
on Oct. To record collection of advance rental To record collection of advance rental
for the period from Oct. 1, 2014 to for the period from Oct. 1, 2014 to
1, 2014 Oct. 1, 2015 Oct. 1, 2015

COMPARATIVE JOURNAL ENTRIES

Adjustin Income Method Liability Method
g entry Rent Income 9,000.00 Unearned Rent Income 3,000.00
on Dec. Unearned Rent Income 9,000.00 Rent Income 3,000.00
31, To record the unearned portion
(liability) of rental collected in To record the earned portion (income)
2014 advance of rental collected in advance
 Effects of Error / Omission on FS

Under Income Method Under Liability Method

➢ Income Statement : Profit is ➢ Income Statement : Profit is

overstated. understated

➢ Balance Sheet : Liability is ➢ Balance Sheet – Liability is

understated and Owner’s overstated and Owner’s Equity
Equity is overstated is understated.
 Prepayment of Expense : Illustration
On September 1, 2014, Rajah Commercial paid an
insurance premium covering the period from
September 1, 2014 to September 1, 2015 in the
amount of P3,600. The accounting period ends on
December 31, 2014.

Upon COMPARATIVE JOURNAL ENTRIES

paymen Expense Method Asset Method
t on Insurance Expense 3,600.00 Prepaid Insurance 3,600.00
Sept. 1, Cash 3,600.00 Cash 3,600.00
2014 To record insurance premium paid To record insurance premium paid
 Adjusting Entry

Adjustin COMPARATIVE ADJUSTING JOURNAL ENTRIES

g entry Expense Method Asset Method
on Dec. Prepaid Insurance 2,400.00 Insurance Expense 1,200.00
31, Insurance Expense 2,400.00 Prepaid Insurance 1,200.00
2014 To record unexpired (asset) portion of insurance premium To record unexpired (asset) portion of insurance premium
 Provision for Estimated Uncollectible Accounts

Business should anticipate a loss that may be

incurred arising from a possibility that credit
customers may not be able to pay their accounts.

Method of Computing Uncollectible Accounts:

1. Percent % of uncollectible account based on

outstanding receivable
2. Aging the accounts receivable
3. Setting up a certain % of uncollectible
account based on credit sales
Methods of Estimating Doubtful Accounts
Aging of Accounts Receivable
Total of each
classification x Rate
or Percent of Loss

A certain Rate x
Accounts Receivable
Balance

Amount of Sales for

the Year x Certain
Rate
 Illustration : Estimating Doubtful Accounts
The allowance for doubtful accounts of Sampaguita
Company showed a credit balance of P33,000. Net
Credit Sales is at P 1,600,000. The company’s
provision for doubtful accounts is based on Aging of
its accounts receivable. Shown below is the aging of
the accounts receivable:
Less than 61-90 91-120 Over 120
Account Balance 60 days days days days

Antiporda P 100,000 P 100,000

Balbakwa 256,000 180,000 P 76,000
Curdapia 654,000 500,000 154,000
Dagul 50,000 P 50,000
Empoy 420,000 P 420,000
Total P 1,480,000 P 780,000 P 230,000 P 420,000 P 50,000

% collectible 99% 95% 85% 60%

 Illustration

Maglipay Co. has an outstanding Accounts

Receivable from various customers in the amount
of P20,000. At the end of its accounting period, it
is estimated that 5% of this is doubtful of
collection.

Compute for the doubtful account and the

adjusting entry.
 Correction of Erroneous Journal Entries
Do the necessary correcting entries for the
following transactions that were erroneously
journalized:

Jan. 1 – Mr. Owner Co, borrowed money from

Land Bank of the Philippines to start his
accounting public practice, P75,000.

Entry made:
Cash In Bank 75,000
Bank Loan Payable 75,000
 Correction of Erroneous Journal Entries

Jan. 10 – Purchased office supplies for inventory

on account from Pautang Co., P5,200.

Entry made:
Office Supplies Expense P5,000
Accounts Payable P5,000
 Correction of Erroneous Journal Entries

Jan. 17 – Rendered professional services on

account to Mr. Customer Sia, P35,000

Entry made:

Cash in Bank 53,000

Professional Income 53,000
 Correction of Erroneous Journal Entries

Jan. 25 – Mr. Owner Co, withdrew cash from his

business, P18,000

Entry made:

Advances to Employees 13,000

Cash In Bank 13,000
 Correction of Erroneous Journal Entries

Jan. 31 – Paid salaries to Juan, his accounting

staff
Salaries and Wages P10,000
Less : Advances to Employees 3,000
Net Pay P 7,000

Entry made:
Salaries and Wages 7,000
Cash in Bank 7,000
Adjusting Entry due to Errors : Sample
Adjusting Entry due to Errors : Sample
Adjusting Entry due to Errors : Sample